January 31, 2018

BUSINESS AND INDUSTRIAL ECONOMICS

[Paola Garrone, Gresa Latifi, Boris Mrkajic]

Academic Year 2016/2017

NAME AND SURNAME _____________________________________________________________

STUDENT ID ______________________________________________________________________

During the BIE exams, students

 Have to arrive on time
 Have to bring and show their ID card
 Must leave their personal belongings (bags, backpacks, etc.) near to the lecturers’ desk
 Must switch off their PC, mobile phones, smartphones and tablets, and cannot use or touch
them
 Cannot cheat or copy their classmates’ work
 Cannot refer to their books, slides or notes
 Can bring a pocket calculator
 Must hand in the text and all the copies of their essay before leaving the exam room
Please note: lecturers will ask students who break the aforementioned rules to leave the exam
room.

Further information
 Students have to fill the name, surname and student ID
 Students are expected to write in a readable way
 Multiple‐choice questions: one and only one answer is correct, and brings positive points;
other answers give rise to neither negative nor positive points, exactly like unanswered
questions.
 You have 2 hours to complete the exam.
 Evaluations will be published by February 8, 2018.
Part I: Multiple‐choice questions [10 points]
(mark the letter of the most correct answer)

An Italian wood furniture company, D&C ‐ Design & Comfort, makes a very large share of its sales in
Asian and American markets. However the European customers are less price‐elastic (price elasticity
of demand,| |) than Asian and American ones: | | 1.5 ; | | 2. The marginal cost of D&C
furniture is estimated to be equal to 100.

a) 100 and 200 are the best prices possible for D&C, as they implement GPD
(group price discrimination)
b) and are the best prices possible for D&C, as they implement GPD
(group price discrimination)
c) 200 and 300 are the best prices possible for D&C, as they implement PPD
(perfect price discrimination)
d) 300 and 250 are the best prices possible for D&C, as they implement PPD
(perfect price discrimination)

You have found out that the market of raw materials for building industry is more concentrated in
Germany than in Japan. Based on that, you draw your conclusions.

a) The materials suppliers operating in Germany may have a greater market power or be less
efficient than materials suppliers operating in Japan
b) Profits in Germany are smaller than in Japan
c) The materials suppliers operating in Germany may have a greater market power or be
more efficient than materials suppliers operating in Japan
d) The industry costs are smaller in Germany than in Japan.

The operators of electricity transmission grids (networks) have very large scale economies. Serving
additional users and expanding the network to serve the whole market reduces the unitary costs.
The network investment is so specific to the market that divestment (exit) is very unprofitable (the
operator is unlikely to recover the residual network value)

a) Electricity transmission is a natural monopoly and a contestable market.

b) Electricity transmission is a natural monopoly. It is not a contestable market.
c) Electricity transmission is not a natural monopoly. It is a contestable market.
d) Electricity transmission is neither a natural monopoly nor a contestable market.

Limit pricing is the highest price that can be charged by an incumbent without inducing new entries
in the market. It works as an entry deterrence strategy according to Milgrom and Robert’s model if

a) It is a signal of the incumbent’s capability to undertake further capacity investment.

b) It is a signal of the incumbent’s cost advantage over the entrants and is sustainable from an
economic point of view.
c) It is a signal of the incumbent’s cost advantage over the entrants and would be
unprofitable if the incumbent had higher costs.
d) It is a signal of the incumbent’s willingness to accommodate the new entrants.
Suppose that in the automative industry in Germany there is one firm (player 1) who considers
entering (action e) in the market where an incumbent is already operating (player 2) and is
generating a profit of π_2=50. Choosing not to enter (e ̅) does not bring any profit to the potential
entrant whereas it leaves the whole existing market to the incumbent firm. However, a entry
decision can alert the incumbent to react aggressively (r) or not (r ̅). If the aggressive reaction is
chosen, there will be a 10 units loss in the profit of both players, whereas the opposite reaction will
benefit the incumbent with 20 and the entrant with 10 units profit. Relying on the information
above, first draw the subsequential game tree below and then choose the answer.

a) The sequential game played in the German automative industry lacks any Nash equilibria.
b) If Player 1 decides to enter, Player’s 2 optimal choice is to choose r.
c) The only subgame perfect Nash equilibrium in this game is (e,r ̅ ).
d) The sequential game played above provides evidence that (e ,̅ r) is reasonably expected to be
played (no).

The Antitrust authority starts a cartel case about the 3 dominant producers of raw building materials
in the country, following the complaints of customers (building industry). The Antitrust authority

a) Can interviewee the staff, but it can’t examine the records of suspected businesses.
b) Can sanction the 3 producers if it demonstrates they have colluded to restrict rivalry.
c) Will sanction the 3 producers because the complaints show that they collude.
d) Will sanction the 3 producers because they are guilty of predatory pricing.

The Antitrust authority is more likely to suspect tacit collusion in markets

e) Where the demand is contracting and few firms survive the industry innovation races
f) Where the demand is growing, and firms are vertically integrated
g) Where the demand is growing, and firms expect to continue to serve the market in next
years
h) Where the demand is contracting, and firms expect to continue to serve the market in next
years

Subsidizing regulated monopolists from the public budget is problematic because

a) It is an instance of soft‐budget constraint, i.e. it implies inequality

 b) It is an instance of soft‐budget constraint, i.e. it implies productive inefficiency
c) It deteriorates the dynamic efficiency of the sector
d) It deteriorates the allocative efficiency of the sector

Only a part of Milano residents has switched to more sustainable forms of mobility (e.g. bicycles,
public transport, walking). This has improved the quality of Milano air. By contrast, less
environment‐conscious residents haven’t changed their unsustainable conducts. Explain why.

a) The cooperative outcome, i.e. all residents contribute to improve air quality, is an
equilibrium in dominant actions.
b) The cooperative outcome, i.e. all residents contribute to improve air quality, cannot be
supported because it is Pareto inefficient.
c) The less environment‐conscious residents know they can’t free ride the sustainable conducts
of other citizens, because those who did not make any effort can be excluded from the
cleaner air benefits.
d) The less environment‐conscious residents know they can free ride the sustainable
conducts of other citizens, because they can’t be excluded from breathing a cleaner air
even if they did not make any effort.

Recently your country has adopted a law that oblige households and businesses to phase out (to
abandon) the use of fuel oil for heating in 5 years. There is a threshold in the concentration of the
particulate matter coming from fuel oil combustion that is harmful for human health. Costs to
replace the fuel oil heaters with more environmentally friendly technologies vary depending on the
building.

a) This is an environmental technology standard.

b) This is an environmental performance standard that is inefficient because of the
heterogeneity of abatement costs.
c) This is a command‐and‐control regulation.
d) The phase‐out obligation is efficient given the heterogeneity of abatement costs.
Part II: Open Question [10 points]
Read the following text and please answer each sub‐question in the new lines that follow it.
Writing must be readable.

Yum is a successful Italian start‐up that offers innovative kitchen appliances and tools, provides
education for the expert cooks (trainers) who use Yum’s products to organise training sessions and
an online two‐sided platform for linking trainers and people looking to learn new techniques and
new recipes. The key product is an advanced, more effective and user‐friendly food processor that
includes a set of tools that facilitates the cook’s tasks with the raw ingredients, i.e. peeling, juicing,
cutting, chopping, mixing, whisking them. It has been developed locally. The development of the
food processor and tools as well as the two‐sided platform was mainly relying on the knowledge of
the founders, who are software engineers, qualified cooks, and business graduates. Yum has
managed to obtain the necessary resources locally, and assembles, manufactures and sells products
using their own retail points of sale in Italy. Laces has also built a network of teachers, who provide
education to the cooks on how to use the food processor and tools most effectively. In that process,
Yum has become the leader in the national market of food processing systems. Following the
success on the national scale, internationalization is considered as a natural step forward for the
company.

One of the Yum’ founders is Leo Fortunato, who attended a prestigious business school in the
country, where he learned about firm internationalisation models. In particular, he specialised on
the topic of the Scandinavian School of Firm Internationalisation (The Uppsala Internationalisation
Model). Hence, he proposed to his co‐founders to use this strategy to expend the business of Yum
across the borders.

If Leo was to create an internalisation roadmap for Yum following the Scandinavian School
approach, how would he:

a) Set up 1‐2 year internationalization strategy.

Possible solution:

The students should mention in the answer the first pattern of internalisation here.
They should mention one (or a very few) country(ies) that should be chosen as the first expansion
market(s), based on the physic distance, which should be explained.
They should mention gradual/incremental resource commitment to facilitate learning and
risk/uncertainty control. They should provide more specific details of how this resource commitment
could unfold.

b) Set up 5+ year internationalization strategy.

Possible solution:

The students should mention in the answer the second pattern of internalisation here.
They should mention how the choice of further expansion should be made (again based on physic
distance, risk and uncertainty).
They should again mention gradual/incremental resource commitment in relation to the previous
point.

c) Present possible pros and cons of this approach?

Possible solution:

The students should mention in the answer that this model is beneficial as it takes into account
dynamics of internationalisation, and allows better control of risk and facilitates learning.
Furthermore, they should point out the following pitfalls: the relationship between learning and
perceived uncertainty is not linear but rather inverted‐u shaped… Yum might miss out on some
opportunities in markets that are far away in terms of physic distance, if they don’t expend there
fast (Internationalisation as opportunity seeking). Second, this model might be less useful to apply
for a company from Italy, which is a rather large country (e.g. the local expansion might have already
facilitated learning).
Part III: Structured question [10 points]
Please answer each sub‐question in the new lines that follow it. Where appropriate addition of figures,
tables, graphs or formulas is possible. Writing must be readable.

For solutions see slides 7. Asymmetric information

a) Define moral hazard

b) What are the main consequences of moral hazard?

c) Explain why the outcome of moral hazard is inefficient

d) Choose an example of a market affected by moral hazard. Explain how moral hazard arises in
that market and what are its main implications.